Article

Journal of Accounting,
Auditing & Finance
The Quality of Management 2015, Vol. 30(2) 127–149
ÓThe Author(s) 2014
Forecasts of Capital Reprints and permissions:
sagepub.com/journalsPermissions.nav
Expenditures and Store DOI: 10.1177/0148558X14544502
jaf.sagepub.com

Openings in MD&A

Cathy J. Cole1 and Christopher L. Jones2

Abstract
We study the quality of retailers’ forecasts of planned capital expenditure and store open-
ings provided in Management’s Discussion and Analysis (MD&A). These are important
examples of forward-looking information included in MD&A. To examine the quality of
these forecasts, we evaluate whether they possess five desirable attributes of management
forecasts, namely, unbiasedness, efficiency, high explanatory power, incremental informative-
ness, and sufficient-statistic efficiency (meaning that the forecasts incorporate all available
information). We find no evidence of bias in the forecasts. We find that the forecasts have
high explanatory power and substantial incremental informativeness relative to historical
information. In our in-sample tests, we find evidence of inefficiency and sufficient-statistic
inefficiency, but our out-of-sample tests find no significant evidence of either, which sug-
gests that it is difficult to improve on these management forecasts. Overall, the evidence
indicates that the forecasts are of high quality. These findings contribute to our under-
standing of the general quality of MD&A information and our results help explain findings
that MD&A disclosures are associated with future accounting results and reduced cost of
capital.

Keywords
Management’s Discussion and Analysis, forward-looking information, management forecasts,
capital expenditures, store openings

Introduction
In this article, we examine the bias, explanatory power, and other attributes of the quality
of capital expenditure and store opening forecasts provided by firms in the retail industry
in the Management’s Discussion and Analysis (MD&A) section of their Form 10-K fil-
ings.1 These forecasts are important examples of forward-looking information that firms
provide in MD&A. The U.S. Securities and Exchange Commission’s (SEC; 1989)

1
University of Texas at San Antonio, USA
2
The George Washington University, Washington, DC, USA

Corresponding Author:
Christopher L. Jones, George Washington University, Funger Hall, Suite 601, 2201 G Street NW, Washington, DC
20052, USA.
Email: jonesc@gwu.edu
128 Journal of Accounting, Auditing & Finance

interpretive guidance for MD&A, the American Institute of Certified Public Accountants’
(AICPA; 1994) Jenkins report, the Financial Accounting Standards Board’s (FASB; 2001)
report on business reporting, and the International Accounting Standards Board’s (IASB;
2010) practice statement on management commentary all encourage additional MD&A dis-
closure, especially forward-looking disclosures.2 These standards setters view forward-look-
ing disclosures as particularly useful in predicting future accounting outcomes.
In this study, we contribute to research on MD&A disclosures by directly examining the
quality of MD&A forecasts of capital expenditures and store openings. In most accounting
research, including research on MD&A, the quality of disclosures is studied indirectly by
examining the usefulness of the disclosures in explaining stock returns or predicting future
earnings. Research on MD&A indicates that MD&A information, including forward-look-
ing disclosures, is informative.3 For capital expenditure and store opening forecasts, it is
possible to define what attributes a high-quality disclosure would possess because the pur-
pose of a forecast is to predict the realized level.4 Consequently, for these two MD&A dis-
closures, it is possible to directly examine their quality by studying their performance as
forecasts. In contrast, it is not possible to directly assess the quality of many disclosures,
especially nonquantitative disclosures, because there often is no objective data with which
to compare the disclosures.
We examine five desirable attributes of forecast quality for management forecasts of
capital expenditures and store openings, namely, unbiasedness, efficiency, explanatory
power, incremental informativeness, and sufficient-statistic efficiency (which we define
below). Each of the five properties should assist investors, analysts, and other users in
making better forecasts of the realized level of the variable at a lower cost. We first test
whether the forecasts are unbiased predictions of the actual level. We test efficiency, which
we also call linear efficiency, by examining whether the intercept and slope in a regression
of actual levels on predicted levels are equal to the values for an efficient forecast, 0 and 1,
respectively. We examine the explanatory power of these forecasts by regressing the rea-
lized levels of the variables on the planned levels. To test for incremental informativeness,
we assess whether the planned levels add additional explanatory power beyond other avail-
able information, such as the current level of the variable. Finally, we examine whether the
planned level reflects all of the available information that firms could use in forecasting
capital expenditures or store openings.5 In that case, it is a sufficient statistic for available
information, so we refer to this property as sufficient-statistic efficiency.
In our empirical analysis, for both capital expenditure and store opening forecasts, we
find no statistically significant evidence of bias. However, while we find no evidence that
capital expenditure forecasts are inefficient, we find store opening forecasts are inefficient.
Our results indicate that both capital expenditure and store opening forecasts have substan-
tial explanatory power. Planned capital expenditure and store opening predictions explain
83.6% and 95.9% of the variation in their respective realized levels. In fact, the planned
variables explain a greater share of the variation in the actual future levels than all of the
historical variables, such as earnings, revenues, and the previous level of the dependent
variable, combined. The historical variables explain 71.1% and 71.3% of the variation in
realized capital expenditures and store openings, respectively. Given these findings, it is
not surprising that planned capital expenditures and store openings are incrementally infor-
mative when added to regressions that include the historical variables. We find that both
capital expenditure and store opening forecasts can be improved in sample by using histori-
cal information that is available to the retailers. This finding suggests that management
does not efficiently incorporate this information into its forecasts disclosed in MD&A.
Cole and Jones 129

Thus, the forecasts are not sufficient statistics for all available information. However, the
improvements in explanatory power from including the historical variables are modest.
In a second part of our tests for efficiency and sufficient-statistic efficiency, we examine
whether information on predictable patterns of linear or sufficient-statistic inefficiency can
be used to produce improved forecasts out of sample. We find no evidence that forecasts
can be improved out of sample, suggesting that the forecasts are fairly efficient, which may
result from the inefficiency being either small or insufficiently persistent.
Our article makes a number of contributions to accounting research. First, we examine
the quality of two important management forecasts, capital expenditures and store open-
ings, which have not previously been studied. Both are common disclosures, with 57% and
70% of retailers, respectively, providing expected levels of capital expenditures and store
openings. Capital expenditures and store openings are significant to firms’ operations and
ability to grow, which may explain why investors are interested in forecasts of this infor-
mation.6 The findings may help analysts and other users in understanding the attributes of
managements’ capital expenditure and store opening forecasts. For example, if management
forecasts exhibit sufficient-statistic efficiency, then the forecasts cannot be improved by
adding other information, and investors can use the forecasts directly without further effort.
Second, examining these forecasts provides insights into the general quality of MD&A
disclosures, especially other forward-looking information.7 These are desirable disclosures
to focus on for this purpose, as we can easily and objectively evaluate the quality because
the realized levels are consistently disclosed in the following year. Regulators and stan-
dards setters may find our results helpful in assessing whether encouraging or requiring
additional forward-looking or other MD&A disclosures is warranted.
Third, studying the properties of these forecasts provides an opportunity to explain the
findings of some past MD&A research that documents that MD&A disclosures in general,
and these specific disclosures in particular, provide useful information to investors. Our
finding that the forecasts are of reasonably high quality complements past research by help-
ing clarify why the forecasts of store openings and capital expenditures are useful.8
Fourth, our results provide insights into the general properties of management forecasts
besides earnings forecasts, which have been the subject of extensive research in the past.
Prior research on management earnings forecasts finds mixed evidence of bias, some evi-
dence of linear inefficiency, and evidence of sufficiency statistic inefficiency.9
Finally, our findings generally support an approach to increasing estimation accuracy
suggested by several research articles and an SEC interpretative release. The articles and
release reason that providing information on the ex post accuracy of accounting estimates,
such as the allowance for doubtful accounts, that entail a forecast of future realizations
related to past transactions provides an incentive for firms to provide more accurate esti-
mates.10 Our article examines MD&A forecasts for which the ex post realization is dis-
closed and finds that capital expenditure and store opening forecasts are generally of high
quality.
The remainder of the article proceeds as follows. ‘‘MD&A Requirements and Planned
Capital Expenditures and Store Openings’’ section discusses the SEC regulations related to
disclosures of planned capital expenditures and store openings. ‘‘Prior Research and
Empirical Expectations’’ section describes previous research on MD&A and discusses how
it relates to our research and expectations for the quality of these forecasts. ‘‘Research
Design’’ and ‘‘Data’’ sections describe our research design and data. ‘‘Capital Expenditure
Results’’ and ‘‘Store Opening Results’’ sections present the results for capital expenditure
130 Journal of Accounting, Auditing & Finance

and store opening forecasts, respectively. ‘‘Out-of-Sample Analysis’’ section presents the
out-of-sample results. ‘‘Conclusion’’ section concludes.

MD&A Requirements and Planned Capital Expenditures and Store

Openings
Management’s forecasts of expected new store openings and capital expenditures are gen-
erally found in the MD&A section of the Form 10-K. The MD&A rules require that man-
agement’s discussion focuses on liquidity, capital resources, and results of operations,
and provides any other information that is necessary to an understanding of company
operations, financial condition, and changes therein (Regulation S-K, Item 303;
SEC, n.d.). The SEC rules place particular emphasis on information that would help
investors predict future accounting outcomes and evaluate the firm. Although most of the
disclosures in the Form 10-K are historical information, a much smaller set is explicitly
forward-looking. Required forward-looking information includes known trends, demands,
commitments, events, or uncertainties that are reasonably likely to affect capital
resources, liquidity, or operations in a material way (SEC, 1989). The SEC encourages
firms to provide more of these forward-looking disclosures in their 10-Ks, but some firms
appear reluctant to do so in spite of safe harbor provisions that lessen the risk of being
sued for inaccurate projections.11
In addition to the general guidance about forward-looking disclosures, the SEC’s
Financial Reporting Release No. 36 discusses circumstances under which firms are required
to disclose their planned capital expenditures. Planned capital expenditures and expected
methods of financing such expenditures must be addressed if the capital spending is neces-
sary to support a known sales growth trend or to ‘‘support a new, publicly announced prod-
uct or line of business’’ (SEC, 1989, Section III.B).
The SEC does not require that retailers disclose their planned store openings but it
encourages the disclosure of planned store openings through its general request for for-
ward-looking information and through a specific example of capital expenditure disclo-
sures. In that example, the SEC cites favorably a retail firm that discloses that it ‘‘plans to
open 20 to 25 new stores in fiscal 1988.’’

Prior Research and Empirical Expectations

In this section, we discuss previous MD&A research, with a focus on research related to
capital expenditures or store opening forecasts and our empirical expectations.12 Most pre-
vious research provides indirect evidence on MD&A quality by assessing whether MD&A
disclosures are helpful to users. We provide insights into the general quality of MD&A dis-
closures by directly examining the properties of two MD&A forecasts. By examining these
forecasts directly, our article complements the earlier research.

Prior Research
Several articles that study the role of specific MD&A disclosures find that MD&A disclo-
sures, particularly forward-looking information including store opening and capital expen-
diture forecasts, provide useful information. McConnell and Muscarella (1985) find that
capital expenditure announcements are associated with short-window stock returns. Bryan
(1997) identifies seven categories of MD&A disclosures and provides evidence that some
Cole and Jones 131

are associated with future revenues, earnings, capital expenditures, and cash flow from
operations or short-window stock returns.13 He finds that MD&A information on future
capital expenditures helps predict realized capital expenditures and is associated with short-
window stock returns. Cole and Jones (2004) find that MD&A disclosures of planned store
openings and planned capital expenditures (and comparable store sales growth) are associ-
ated with future earnings, future revenues, and contemporaneous stock returns for retail
firms.
Other articles find that the quality, length, or tone of forward-looking MD&A disclo-
sures are informative. Barron, Kile, and O’Keefe (1999) find that better rated MD&A dis-
closures as assessed by the SEC are associated with more accurate and less dispersed
analyst earnings forecasts. They look at types of MD&A disclosures and find that forward-
looking capital expenditures, as well as historical capital expenditures and forward-looking
operations disclosures, are particularly important. Muslu, Radhakrishnan, Subramanyam,
and Lim (in press) report that providing more forward-looking MD&A disclosures is asso-
ciated with improvements in firms’ information environment, in particular the degree to
which stock returns incorporate information about future earnings. They find that forward-
looking information on investments, a category that includes store openings and capital
expenditures, is one of the categories that contributes to improved informational efficiency
of stock prices. Li (2010) finds that the tone of forward-looking MD&A disclosures is asso-
ciated with future earnings and liquidity and analyst earnings forecasts. The study also
finds that the tone of liquidity-related forward-looking statements, which would include
those related to capital expenditures and new stores, is associated with future earnings and
cash flows from operations.
A number of other articles have found that MD&A disclosures in general provide useful
information. Articles by Francis, Schipper, and Vincent (2003); Behn, Kaplan, and
Krumweide (2001); and Sun (2010) find that specific MD&A disclosures are associated
with contemporaneous stock returns, auditor’s going concern opinions, and future revenue
growth and return on assets (ROA), respectively. In addition, articles using computer-inten-
sive techniques focusing on textual disclosures find that MD&A tone, length, or content is
associated with short-window stock returns or future ROA.14
Two articles that directly examine the quality of MD&A disclosures suggest that quality
may be fairly low. Using a small sample, Pava and Epstein (1993) find that only 49% of
the firm-specific events identified from other sources were anticipated in MD&A and that
good news items were more often predicted than bad news. Clarkson, Kao, and Richardson
(1994) find that favorable earnings forecasts in MD&A are much more frequently associ-
ated with decreases in earnings than unfavorable forecasts are associated with increases in
earnings. The results in both articles suggest that MD&A disclosures have an optimistic
bias.
Past research documents that MD&A disclosures, in particular forward-looking disclo-
sures, provide useful information and provides some evidence that the direct quality of the
information may be biased. In general, although value relevant or otherwise useful infor-
mation is more likely to be of high quality in terms of the direct properties of the fore-
cast, it is not necessarily the case that it will be of high quality. For example, research
documents that management earnings forecasts lead to adjustments in share prices (Patell,
1976; Penman, 1980) but other research (as discussed in and near Note 9 in the
‘‘Introduction’’ section) finds that such forecasts are biased and are not sufficient-statistic
efficient.15
132 Journal of Accounting, Auditing & Finance

Properties of Forecast Quality and Expectations

The five properties. A high-quality forecast should be unbiased, efficient, highly associated
with the realized level, a source of useful information, and incorporate all available infor-
mation. In this section, we first describe why each of these properties is important to fore-
cast quality. We then discuss factors that will tend to increase forecast quality followed by
a discussion of factors that may limit quality as measured by each of the five properties.
Three of the properties, bias, efficiency, and sufficient-statistic efficiency, are important
measures of quality because they address whether there are systematic errors in the fore-
cast. High-quality forecasts should have little or no systematic error.16 Users of forecasts
that are not unbiased, efficient, and sufficient-statistic efficient may be unaware of the sys-
tematic errors and may incorporate those errors into their own forecasts. Even if they are
aware of the systematic errors, users need to be able to estimate the degree of bias or ineffi-
ciency and expend effort to correct it. As Fried and Givoly (1982) note, ‘‘Whether users
actually employ corrected forecasts depends on the cost of adjustment’’ (p. 92). If a man-
agement forecast is sufficient-statistic efficient, users need to gather no additional informa-
tion to produce their own forecasts because the management forecast would incorporate all
available information.
Explanatory power and incremental informativeness are also desirable forecast proper-
ties.17 Management forecasts that are highly predictive of the realized level involve smaller
forecast errors, so users can more confidently use the information to produce other fore-
casts. Users are particularly likely to find useful those management forecasts that provide
incremental information beyond that available from other sources.

Empirical expectations. A number of factors suggest that the capital expenditure and store
opening forecasts provided in MD&A should be of reasonably high quality. Capital expen-
ditures and store openings may be easier to forecast, because they are probably less sensi-
tive to external factors than other common forecasts, such as earnings. Capital spending
and store opening plans are often determined well in advance, which makes the realized
level easier to forecast. Furthermore, management may have incentives to provide good
forecasts to demonstrate managers’ own ability and enhance their reputation (Graham,
Harvey, & Rajgopal, 2005; Trueman, 1986) or to reduce information asymmetry and trad-
ing costs (Hutton & Stocken, 2009).
Capital expenditure and store opening forecasts may exhibit the properties of bias and
inefficiency as a result of unintentional or deliberate actions by management that lead to
systematic errors.18 Unintentional systematic errors could result if the forecast does not rep-
resent an expected value, that is, a probability-weighted average of all possible outcomes.19
For example, management may instead provide the most likely outcome or the budgeted
amount and that can lead to systematic errors if those differ from the mean value.20
Unintentional systematic errors could also result if, for example, management consistently
overpredicts capital expenditures due to management’s strong belief in the firm’s retail
concept, its prospects and resultant ability to expand. Management might deliberately bias
forecasts upward to deter potential competitors (Bamber & Cheon, 1998) or to boost share
prices, especially if the firm is considering issuing equity.21 Alternatively, management
might bias the forecasts downward to reduce the risk of securities litigation (Rogers &
Stocken, 2005) or to influence analysts to reduce their forecasts to an achievable level
(Baik & Jiang, 2006). The findings of Pava and Epstein (1993) and Clarkson et al. (1994)
suggest optimistic bias may be common in MD&A.
Cole and Jones 133

Several factors may reduce the explanatory power of management forecasts of capital
expenditures and store openings. First, firms that make capital expenditure and store open-
ing forecasts tend to do so every year.22 That may reduce forecast accuracy because firms
do not appear to selectively provide forecasts in the years when uncertainty is lower.
Second, corporations release their annual 10-Ks at least 9 months before the end of the
fiscal year. This means that there is time for deviations from forecasts to occur because
management changes spending plans or is unable to execute the original plan. For example,
spending decisions may be altered due to changes in the overall economy, the success of
an existing or new retail format, or to changes in access to funds available for capital
spending. Deviations from forecasts can also occur because of unpredictable external
events that make it impossible to follow a plan such as changes in input costs, weather and
other construction delays, and delays in getting governmental approvals.
Whether the forecasts provide incremental information will depend on (a) how effective
other information is in predicting future levels and on (b) the explanatory power of the fore-
casts. The factors we discussed that may lead to systematic errors or low explanatory power
may also reduce incremental informativeness. Still, it is likely that management forecasts will
have incremental explanatory power beyond predictions that can be made based on publicly
available information because the firm has access to its own internal planning information.
The findings of McConnell and Muscarella (1985), Bryan (1997), and Cole and Jones (2004)
are consistent with the idea that management forecasts of capital expenditures and/or store
openings contain information that is not otherwise available.
Several factors might lead to forecasts failing to exhibit the property of sufficient-statis-
tic efficiency. Forecasts may not be sufficient-statistic efficient if management is inefficient
about incorporating other information or is not trying to minimize forecast error. Inefficient
forecasts can result if management focuses primarily on its own private information in
making forecasts and does not sufficiently incorporate external information.23 If firms pro-
vide the most likely number or the budgeted number that could produce forecasts that can
be improved by including other information.

Research Design
This study’s tests are designed to explore the bias, efficiency, explanatory power, incre-
mental informativeness, and sufficient-statistic efficiency of management’s forecasts of
capital expenditures and store openings of retail firms provided in MD&A. For reasons of
parsimony, we only describe the specifications and analysis for the capital expenditure
regressions in this section. The analysis is identical for store openings. We further examine
the efficiency and sufficient-statistic efficiency of these forecasts using out-of-sample tests.
We describe those tests in the ‘‘Out-of-Sample Analysis’’ section.

Tests of Forecast Properties

Bias. To determine whether the forecasts are biased, we use three tests that examine the dis-
tribution of forecast errors. Forecast error is computed by subtracting the predicted level
from the actual realized level of the variable (forecast error = actual 2 predicted). To
adjust for differences in the scale of operations, capital expenditures in period t+1 is
divided by total assets in period t and store openings in t+1 is divided by the number of
stores that were open in t. The planned variables are scaled by the same factors. We use
sign, signed rank, and means tests to examine whether forecast errors systematically differ
134 Journal of Accounting, Auditing & Finance

from 0.24 In the sign test, we examine whether the percentage of positive and negative fore-
cast errors indicates a systematic bias or whether the distribution could have resulted ran-
domly if the underlying probability of each event was equal. The signed rank test examines
the relative size of positive and negative forecast errors. The means test examines whether
the mean forecast error is statistically different from 0. Of these three tests, the sign and
signed rank tests are less influenced by large non-normal forecast errors.

Efficiency. We test whether management’s forecasts of planned capital expenditures are

efficient forecasts of the realized (actual future) levels. An efficient forecast is one that
does not have systematic forecast errors that can be reduced by linear adjustments. To
examine whether linear adjustments can be used to produce forecasts that are significantly
more accurate than the planned levels, we regress the actual level of capital expenditures in
the following year on the forecasted number provided in the current year’s annual report.
The regression equation is

CEt + 1 = a + b1 PCEt + e, ð1Þ

where CEt + 1 is the level of capital expenditures in time t + 1 divided by total assets at
time t, PCEt is the planned capital expenditures in time t + 1 as forecast at time t divided
by total assets at time t, and E is the error term. If a forecast is an efficient predictor of the
actual future level, the intercept will equal 0 and the coefficient on the planned level will be
1.25 If the values differ from 0 and 1, it suggests that management’s prediction could be
improved by using the estimated coefficients to develop an alternative adjusted prediction.
Mincer and Zarnowitz (1969) refer to this as a test of the efficiency of the forecast, because
a forecast that can be improved by making a simple linear adjustment is clearly not efficient.

Explanatory power. We assess the explanatory power of management’s forecasts by exam-

ining the adjusted r2 statistic from Specification 1, which includes only the planned level.
A more successful forecast should explain more of the variation in the realized level. To
provide some context for the explanatory power of management’s forecasts, we compare it
to the explanatory power of a set of historical variables, such as capital expenditures, earn-
ings, revenues, cash flow from operations and comparable store sales growth, that are
likely to be useful in predicting the realized level of the variable. The explanatory power of
the historical variables for the realized level of capital expenditures is measured using the
following equation:

X
13
CEt + 1 = a + Bj HVjt + e, ð2Þ
j=2

where HV are the historical variables and j = 2 . . . 13. We discuss the historical variables
in greater detail below.

Incremental information content. To examine whether planned capital expenditures has

incremental information content, we include it in a regression with the historical variables.
This allows us to test whether the planned level is useful in predicting the actual level of
capital expenditures after controlling for historical information. This test is accomplished
using the following equation:
Cole and Jones 135

X
13
CEt + 1 = a + b1 PCEt + Bj HVjt + e, ð3Þ
j=2

where j = 2 . . . 13. We test whether b1 = 0.

Sufficient-statistic efficiency. In our sufficient-statistic-efficiency tests, we examine whether

management efficiently incorporates all available information into its projections of
planned levels of capital expenditures and store openings. If management’s forecasts incor-
porate all available information, then including additional variables should not contribute to
the explanatory power of regressions of the actual future level on the planned level. As pre-
viously discussed, this is a different test of efficiency than the linear efficiency test because
it examines whether the planned capital expenditure forecast is a sufficient statistic that
captures all readily available information that could be used to produce an accurate fore-
cast. To distinguish this from Mincer and Zarnowitz’s concept of efficiency, we refer to
this second type of efficiency as sufficient-statistic efficiency. We use that term because if
planned capital expenditures is efficient in capturing all available information, it alone is a
sufficient statistic for users who want to create their own forecast.
In our empirical analysis, we test whether the historical accounting information is useful
in predicting the actual future level of capital expenditures after controlling for the planned
level of capital expenditures. In our tests, we examine the incremental role of a set of
potentially important historical variables, but we cannot include all possible alternative
information in our analysis. We test whether the joint restriction that the estimated coeffi-
cients for the historical variables are 0 can be rejected (bj = 0 for j = 2 . . . 13). This is
done using an F test to determine whether the explanatory power of Specification 3 is sta-
tistically significantly greater than that of Specification 1.

Historical Explanatory Variables

We select a number of historical variables that are likely to be associated with the realized
level of capital expenditures and store openings. The definitions of the historical variables
are provided in Table 3. We include the same set of variables in the capital expenditure
and store opening analyses because the same set of factors are likely to affect both depen-
dent variables as a significant amount of capital expenditures relates to store openings.26
The level of capital expenditures in the current year is likely to be the most important
historical variable in the capital expenditure analysis because the level is likely to be persis-
tent. We also include changes in capital expenditures, because capital expenditures may
tend to increase again following an increase or may tend to revert toward previous levels.
Many of the other variables we include are financial accounting measures that may con-
tain information about the retailers’ success and ability to obtain cash to fund future expan-
sion. We include the level and change of both revenues and income because faster growing
and more profitable companies are likely to have a greater need for additional capacity and
a greater ability to generate internal or to obtain external financial resources to fund the
capacity expansion.27 We also include cash flow from operations because the additional
cash can be used to purchase capacity.28 Cash flow obtained from financing provides addi-
tional resources for future capacity expansion, but it may also reflect less ability to generate
cash internally.
We also include several industry-specific measures that we hand-collect from the retai-
lers’ MD&A and other 10-K disclosures. In particular, we include the level of store
136 Journal of Accounting, Auditing & Finance

openings and closings and the level and change in comparable store sales growth. In the
store opening analysis, the level of store openings is likely to be the most important histori-
cal variable.29 Store openings may also be an important variable in the capital expenditure
analysis because a significant amount of capital expenditures relates to spending on open-
ing new stores. We include store closings as an additional explanatory variable because if a
firm is closing a significant number of stores, it may be struggling and less able or less
inclined to open new stores or to spend money on capital expenditures. Comparable store
sales growth is a prominent industry-specific measure that calculates the percentage change
in revenues at retail locations that are open in both the current and previous year. We
include the level and change of comparable store sales growth, because previous research
finds that both contain useful information.30

Data
Our initial sample consists of all retailers (Standard Industrial Classification [SIC] Codes
5200-5999) with data available on the Compustat Annual Industrial File for the fiscal years
from 1996 through 2000. Information on historical store openings, store closings, planned
capital expenditures, planned store openings, and comparable store sales growth is hand
collected from Form 10-K filings in the SEC’s EDGAR database and the remaining vari-
ables are from Compustat. We use the 1996 starting date because from that point forward
all firms were required to file their 10-Ks electronically on the EDGAR system and data
are substantially easier to collect using EDGAR.
We restrict our analysis to retailers where the in-store business is dominant to produce a
more homogeneous sample in which the historical variables, such as revenues and profits,
relate to the retail business. That restriction should enhance the relevance of the historical
variables because their association with future capital expenditures or store openings
should be more similar across firms. We exclude firms with large Internet, catalog, whole-
sale, or other non-retail businesses.31 We also eliminate firms with substantial franchising
businesses from our sample. We remove all restaurants because franchising is so prominent
among many large chain restaurants.
We also require that the observations have data for all the variables we study. This pro-
duces a sample of 760 firm-year observations for the capital expenditure analysis and 752
observations for the store opening analysis.
We also exclude observations if the company acquired another firm or purchased retail
locations in year t + 1, t, or t 2 1. These requirements eliminate 30% of the observations
from both samples. Table 1 shows this and other steps related to our sample. We eliminate
these observations because acquisitions in year t + 1 affect the realized levels of store
openings and capital expenditures and acquisitions in year t or t 2 1 affect the explanatory
variables, such as revenues and income, and can distort the typical relationship among
variables.
We lose a sizable number of observations because the retailer elects not to provide fore-
casts. The requirement that there be a forecast reduces the sample from 534 to 305 for the
capital expenditure analysis and reduces the store opening sample from 530 to 371.32 We
also remove observations with open-interval forecasts because a forecast that a company
will open at most 30 stores should not be treated as a forecast of 30 store opens. We
include range forecasts, using the mean of the range as the predicted level.
In the store opening analysis, we drop 58 observations where the retailer had less than
50 stores operating at the end of year t. The fact that the number of stores is a discrete
Cole and Jones 137

Table 1. Sample Selection.

Panel A: Capital Expenditures.

Number of observations
Firm-year observation requirements
Historical variables all available 760
No acquisition or disposition 534
A forecast available 305
Forecast must be point or range estimate 292

Panel B: Store Openings.

Number of observations
Firm-year observation requirements
Historical variables all available 752
No acquisition or disposition 530
A forecast available 371
Forecast must be point or range estimate 354
Has at least 50 stores open 296

instead of a continuous measure becomes more of a problem for smaller companies because
in our analysis the actual and forecast numbers are divided by the number of stores cur-
rently operated and when that number is small, a forecast error of one store can be siz-
able.33 These steps produce a sample of 292 observations from 124 firms in the capital
expenditure analysis and 296 (117 firms) in the store opening analysis.
The mean level of planned store openings as a percentage of stores open is 10.5%,
whereas the realized mean level is 10.6%. The mean planned level of capital expenditures
is 9.7% of total assets compared with a realized mean level of 9.8%. The numbers suggest
that these firms are expanding substantially.

Capital Expenditure Results

In this section, we report the results for our analyses of the bias, efficiency, explanatory
power, incremental informativeness, and sufficient-statistic efficiency of management’s
forecasts of capital expenditures.
To test for bias, we compare the realized level with the projected level from the 10-K in
the previous year. If forecasts are unbiased, half of the observations would have positive
forecast errors, the signed rank test would reveal no bias and the mean forecast error would
be 0. The results shown in Table 2 indicate that the forecast level is larger than the realized
level (negative forecast error) for 157 of the 292 observations (53.8%), so the majority of
retailers overestimate capital expenditures. This proportion is not statistically significantly
different from 50% at the 5% significance level. The signed rank test also provides no evi-
dence of bias. The mean forecast error is not significantly different from 0. Thus, the
results from all three tests are not statistically significantly different from those that would
occur if the forecasts were an unbiased estimate of the actual level.
We next explore the linear efficiency of the capital expenditure forecasts. The first
column in Table 3 presents the results from a regression of the realized level of capital
138 Journal of Accounting, Auditing & Finance

Table 2. Tests of Bias for Planned Capital Expenditures (N = 292).

Panel A: Distribution of Forecast Errors.

Percentiles
M 10th 25th Median 75th 90th
0.0002 20.0276 20.0156 20.0012 0.0119 0.0270

Panel B: Number of Positive and Negative Forecast Errors.

Negative Correct Positive
157 (53.8%) 0 135 (46.2%)

Panel C: p Values for Tests of Forecast Errors Being Randomly Distributed Around 0.
Mean test Sign test Signed rank test
0.919 0.219 0.357

expenditures on the planned level provided in the previous year’s 10-K.34 Because we test
whether the coefficient on planned capital expenditures is equal to 1 instead of equal to 0,
we present standard errors of the coefficients instead of t statistics in Tables 3 and 5. The
estimated intercept is 0.002 and the slope coefficient is 0.982. Our tests indicate that we
cannot reject the joint hypothesis that the intercept is equal to 0 and the slope coefficient is
equal to 1. This finding indicates that we cannot reject the hypothesis that the capital
expenditure forecast is an efficient predictor of the actual realized level of capital
expenditures.
As can be seen in the first column of Table 3, the planned level of capital expenditures
explains 83.6% of the variation in the actual level.35 By way of comparison, the results in
the second column indicate that the historical variables explain 71.1% of the variation.36
Thus, planned capital expenditures explains more of the variation than all of the other his-
torical variables combined. The difference is statistically significant based on a Vuong test
(z statistic = 3.64).
The results shown in the second column for the regression including just the historical
variables indicate that many of them are significant. Store openings, the level and change
in capital expenditures, change in income, cash flows from operations, and comparable
store sales growth all are positively associated with future capital expenditures.
Unsurprisingly capital expenditures in the current year is the most powerful predictor of
the future level. In an untabulated regression, it explains 51.1% of the variation in future
capital expenditures.
As shown in column 3 of Table 3, planned capital expenditures contributes substantial
incremental explanatory power when it is included in a regression with the historical vari-
ables, indicating that the planned level is informative. The explanatory power increases
from 71.1% (Specification 2) to 85.5% (Specification 3), which is unsurprising given that
the planned capital expenditures alone is a better predictor than the historical variables.
The finding that planned capital expenditures provides incremental information in predict-
ing future levels is consistent with Bryan (1997). He finds that information on whether the
planned level of capital expenditures is greater than the current level helps predict whether
future capital expenditures increase or decrease.
Cole and Jones 139

Table 3. Planned Capital Expenditure Regressions.

CEt + 1 = a + b1 PCEt + e: ð1Þ

X
13
CEt + 1 = a + Bj HVjt + e: ð2Þ
j=2

X
13
CEt + 1 = a + b1 PCEt + Bj HVj t + e: ð3Þ
j=2

(1) (2) (3)

INTERCEPT 0.002 (0.003) 0.001 (0.008) 0.003 (0.006)
PCE 0.982 (0.026)* 0.782 (0.047)* ,y
OPENSTR 0.055 (0.019)* ,y 0.039 (0.013)*
CLOSESTR 20.017 (0.039) 20.035 (0.028)
CAPEXP 0.698 (0.062)* 0.161 (0.055)*
CHGCAPEXP 0.140 (0.062)* 0.066 (0.044)
INC 0.027 (0.039) 20.016 (0.028)
CHGINC 0.060 (0.026)* 0.031 (0.019)
REVS 0.005 (0.003) 20.001 (0.002)
CHGREVS 0.009 (0.008) 20.000 (0.005)
CFO 0.130 (0.034)* 0.004 (0.025)
CFF 20.040 (0.032) 20.056 (0.023)*
COMPS 0.209 (0.049)* 0.073 (0.036)*
CHGCOMPS 20.045 (0.037) 0.010 (0.026)

Adjusted R2 .836 .711 .855

F value for joint test; a = 0 and b1 = 1 0.25 [.781]
F value for joint test; bj = 0, j = 2 . . . 13 4.14* [.001]

Note. Entries are estimates (SE) and [p values]; N = 292. Variable definitions: CEt + 1 = capital expenditures in year
t + 1 divided by total assets at end of year t; PCEt = forecast of year t + 1 planned capital expenditures made at
time t divided by total assets at the end of year t; HVjt = historical competitor variables in year t as listed below,
where j = 2 . . . 13; Et = error term in year t. Historical competitor variables (HV) consist of the following:
OPENSTRt = the number of stores opened in year t divided by the number of stores at the end of year t;
CLOSESTRt = the number of stores closed in year t divided by the number of stores at the end of year t; CAPEXPt
= capital expenditures in year t divided by total assets at end of year t; CHGCAPEXP = the change in capital expen-
ditures in year t divided by total assets at end of year t; INCt = net income before extraordinary items of in year t
divided by total assets at end of year t; CHGINCt = the change in net income before extraordinary items in year t
divided by total assets at end of year t; REVSt = revenues in year t divided by total assets at end of year t; CHGREVSt
= the change in revenues in year t divided by total assets at end of year t; COMPSt = comparable store sales growth
in year t; CHGCOMPSt = the change in COMPS in year t; CFOt = cash flow from operations in year t divided by total
assets at end of year t; CFFt = cash flow from financing in year t scaled by total assets at end of year t.
*Significantly different from 0 at 5% significance level. ySignificantly different from 1 at 5% significance level (only
applied to planned capital expenditures).

The results from Specification 3 can be used to evaluate whether planned capital expen-
ditures is an efficient predictor in the sense that it is a sufficient statistic. It is not if the his-
torical variables also help predict the realized level of capital expenditures. The historical
140 Journal of Accounting, Auditing & Finance

variables included in Specification 3 make a statistically significant incremental contribu-

tion to the ability to predict capital expenditures (F statistic = 4.14, p value = .001).
Together, the historical variables explain an additional 1.9% of the variation in future capi-
tal expenditures (the increase in r2 from 83.6% to 85.5% from Specifications 1 to 3). Store
openings, capital expenditures, cash flow from financing, and comparable store sales
growth are statistically significant predictors of future capital expenditures. In ‘‘Out-of-
Sample Analysis’’ section, we test whether the estimated in-sample coefficients can be
used out of sample to improve forecasts.

Store Opening Results

In this section, we present the results of our analysis of the bias, efficiency, explanatory
power, incremental informativeness, and sufficient-statistic efficiency of management’s
forecasts of store openings. We test for bias by examining the relative frequency of positive
and negative forecast errors, by using a signed rank test and by testing whether the mean
error is significantly different from 0. The results are shown in Table 4. Of the 296 store
opening forecasts, 56 (18.9%) have no forecast errors. In these cases, management was
able to correctly predict the number of stores that the company opens. In 122 (41.2%)
cases, the retailer opens more stores than it anticipated (positive errors). In the remaining
118 (39.9%) cases, the retailer overestimates the number of new stores it will open during
the upcoming year. The sign test indicates that the proportion of positive forecast errors is
not significantly different from what would occur if the true population likelihood of posi-
tive and negative errors was equal. A signed rank test also indicates that there is no statisti-
cally significant evidence of bias. In the test based on the mean error, we find that the
mean error (0.0012) is not statistically significantly different from 0. In sum, none of these
tests provide evidence of bias.
To test whether store opening forecasts are an efficient predictor of the actual future
level, we regress the realized future level on the predicted level. The regression results,
reported in the first column in Table 5, indicate that the estimated value for the intercept
and coefficient are 20.006 and 1.070. A joint test of the restriction that the intercept and
coefficient are 0 and 1 is rejected. The results indicate that retailers’ forecasts of store
opens are not efficient predictors of the actual realized store opens. The intercept is signifi-
cantly less than 0 and the coefficient is significantly more than 1. The results indicate that
retailers tend to overpredict the actual store openings for low predicted store opens (mea-
sured relative to the number of stores that the firm operates) and to underpredict the level
for high predicted levels. In both cases, retailers’ predictions are closer to the mean of the
sample than are the actual outcomes.
Store opening predictions explain 95.9% of the variation in the realized levels. One
reason that the explanatory power may be so high is because for many retail formats the
company needs to begin the construction projects months or even years in advance of open-
ing new retail locations. Knowing how many projects are underway makes it easier to
anticipate the number that will be completed in the next year. This strong explanatory
power for planned store openings far exceeds that of the historical variables that we use in
Specification 2, which explain 71.3% of the variation. A Vuong test (z statistic = 8.26)
indicates that this difference is statistically significant.
The results indicate that certain historical variables, namely, store openings, capital
expenditures, cash flow from operations, and comparable store sales growth, are statisti-
cally significant predictors of future store opens.37 The current level of store opens has the
Cole and Jones 141

Table 4. Tests of Bias for Planned Store Openings (N = 296).

Panel A: Distribution of Forecast Errors.

Percentiles
M 10th 25th Median 75th 90th
0.0012 20.0199 20.0097 0.0000 0.0088 0.0209

Panel B: Number of Positive and Negative Forecast Errors.

Negative Correct Positive
118 (39.9%) 56 (18.9%) 122 (41.2%)

Panel C: p Values for Tests of Forecast Errors Being Randomly Distributed Around 0.
Mean test Sign test Signed rank test
0.324 0.847 0.985

highest explanatory power. Based on untabulated results, it alone explains 63.2% of the
variation in actual realized store opens in the following year.
There is strong evidence of the incremental predictive ability of planned store openings
when it is included in a regression along with the historical variables. A t test for the signif-
icance of the planned level of store opens indicates that it is highly significant. Including
planned store openings increases the r2 from 71.3% to 96.1%. Clearly management’s fore-
cast is a very helpful factor in predicting future store openings.
To test for the sufficient-statistic efficiency of store opening forecasts, we examine
whether the historical variables are statistically significant in Specification 3. The historical
variables are collectively statistically significant (F value = 2.38, p value = .006). The his-
torical variables explain a modest additional 0.2% of the variation. This can be seen by
comparing the r2 in Specification 3 (96.1%) with that in Specification 1 (95.9%) that
includes only planned store openings. This modest increase in explanatory power indicates
that the historical variables provide little information beyond that captured by the planned
level of store opens. Reflecting this, comparable store sales growth is the only historical
variable that has a statistically significant estimated effect.
In additional analysis, we test for bias and inefficiency of store closing forecasts.
Because there are only 64 firm-years with store close forecasts and there are several
extreme outliers, the results are less reliable. We find that store closing forecasts are biased
and inefficient.38 Both results indicate that firms systematically underestimate the number
of store closes.

Out-of-Sample Analysis
Our tests of efficiency and sufficient-statistic efficiency indicate that for three of the four
analyses, management’s forecasts can be adjusted on the basis of the regression estimates
to produce improved forecasts in sample. These findings suggest that the retailer or analysts
could make similar adjustments and produce more accurate forecasts. For example, one
could use the estimates from Specification 1 to produce an adjusted store opening forecast
142 Journal of Accounting, Auditing & Finance

Table 5. Planned Store Openings Regressions.

SOt + 1 = a + b1 PSOt + e: ð1Þ

X
13
SOt + 1 = a + Bj HVjt + e: ð2Þ
j=2

X
13
SOt + 1 = a + b1 PSOt + Bj HVjt + e: ð3Þ
j=2

(1) (2) (3)

INTERCEPT 20.006 (0.002)* 20.004 (0.013) 20.004 (0.005)
PSO 1.070 (0.013)* ,y 1.069 (0.025)* ,y
OPENSTR 0.960 (0.064)* 0.015 (0.032)
CLOSESTR 20.065 (0.046) 20.003 (0.035)
CAPEXP 20.182 (0.083)* 20.046 (0.031)
CHGCAPEXP 0.144 (0.094) 20.003 0.035
INC 0.006 (0.054) 20.027 (0.020)
CHGINC 0.025 (0.057) 0.018 (0.021)
REVS 0.005 0.004 0.000 0.002
CHGREVS 0.003 (0.012) 0.002 (0.004)
CFO 0.125 (0.053)* 20.019 (0.020)
CFF 0.059 (0.051) 20.021 (0.019)
COMPS 0.213 (0.073)* 0.086 (0.027)*
CHGCOMPS 0.090 (0.056) 0.002 (0.021)

Adjusted R2 .959 .713 .961

F value for joint test; a = 0 and b1 = 1 15.18 [.001]*
F value for joint test; bj = 0, j = 2 . . . 13 2.38 [.006]*

Note. Entries are estimates (SE) and [p values]; N = 296. Variable definitions: SOt + 1 = number of store openings in
time t + 1 divided by the number of stores at end of year t; PSOt = forecast of time t + 1 planned store open-
ings made in time t divided by total stores operated at end of year t; HVjt = historical competitor variables in year t
as listed below, where j = 2 . . . 13; Et = error term in year t. Historical competitor variables (HV) consist of the
following: OPENSTRt = the number of stores opened in year t divided by the number of stores at the end of year t;
CLOSESTRt = the number of stores closed in year t divided by the number of stores at the end of year t; CAPEXPt
= capital expenditures in year t divided by total assets at end of year t; CHGCAPEXP = the change in capital expen-
ditures in year t divided by total assets at end of year t; INCt = net income before extraordinary items in year t
divided by total assets at end of year t; CHGINCt = the change in net income before extraordinary items in year t
divided by total assets at end of year t; REVSt = revenues in year t divided by total assets at end of year t;
CHGREVSt = the change in revenues in year t divided by total assets at end of year t; COMPSt = comparable store
sales growth in year t; CHGCOMPSt = the change in COMPS in year t; CFOt = cash flow from operations in year t
divided by total assets at end of year t; CFFt = cash flow from financing scaled by total assets at end of year t.
*Significantly different from 0 at 5% significance level. ySignificantly different from 1 at 5% significance level (only
applied to planned store openings).

by multiplying management’s store opening forecast by b and adding a. This adjusted fore-
cast should outperform that actual forecast. However, it is possible that even though fore-
casts could have been improved ex post, no user of the information could make the same
sort of adjustment ex ante and outperform managements’ forecasts.
Cole and Jones 143

In this section, we examine the effectiveness of these adjustments out of sample by com-
paring the accuracy of the planned level with alternative predictions calculated using the
coefficients estimated using data from earlier years. For each year, we produce adjusted
forecasts based on coefficients estimated using the available earlier years of data.39
Overall, the results from the out-of-sample analysis indicate that making adjustments to
the management’s forecasts on the basis of either Specification 1 or Specification 3 never
leads to statistically significant improvements in forecast errors. In fact, untabulated results
indicate that the adjusted forecasts are generally less accurate than management’s forecasts.
The findings suggest that the lack of efficiency and sufficient-statistic efficiency that we
document in sample are not large or persistent enough to be used in practice to improve on
management’s forecasts. This finding and the modest incremental explanatory power of the
historical variables in sample suggest that management’s forecasts of capital expenditures
and store openings are reasonably efficient.

Conclusion
We directly examine the properties of retail firm capital expenditure and store opening
forecasts and find that both are of high quality. We find no significant evidence of forecast
bias for capital expenditure and store opening forecasts. The results provide no evidence of
inefficiency for the capital expenditure forecasts but we find store opening forecasts are
inefficient. For both variables, the planned level explains a large portion of the variation of
the realized level and provides substantial incremental explanatory power when included in
regressions along with historical information. In the in-sample tests, neither forecast is
found to be a sufficient statistic for all available information, indicating neither is fully effi-
cient in incorporating all available information. In out-of-sample analysis, we further exam-
ine efficiency and sufficient-statistic efficiency and find that adjusting the firms’ forecasts
based on past patterns of forecast errors produces at most modest and statistically insignifi-
cant improvements in forecast accuracy for both forecasts. In fact, in most cases, the firms’
forecasts beat the adjusted forecasts.
This article makes a number of contributions. Our findings provide evidence on the
direct quality of two important management forecasts. Directly examining the quality of
two MD&A disclosures is useful and the results provide support to the perspective of stan-
dard setters, including the AICPA, SEC, and IASB, that have encouraged additional
MD&A disclosures. Our results may help explain past findings that MD&A research is
value relevant. This article expands the set of management forecasts for which forecast
properties have been directly examined, with the results suggesting that the properties of
capital expenditure and store opening forecasts differ from those of earnings forecasts.

Acknowledgments
We would like to thank the Editor-in-Chief Bharat Sarath and an anonymous reviewer. We would
also like to thank William Baber, Steve Hansen, Krishna Kumar, Kumar Visvanathan and seminar
participants at Georgetown University, the Frank Batten Forum in Accounting at the College of
William and Mary, and the University of Texas at San Antonio.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/
or publication of this article.
144 Journal of Accounting, Auditing & Finance

Funding
The author(s) received no financial support for the research, authorship, and/or publication of this
article.
Notes
1. Some firms provide these forecasts in parts of the Form 10-K besides Management’s Discussion
and Analysis (MD&A). We use MD&A disclosures to refer to these and other disclosures that
typically appear in MD&A.
2. See also discussions of forward-looking information in the SEC’s other interpretive releases on
MD&A (SEC, 2003, 2010).
3. We discuss research that finds MD&A disclosures are informative in the ‘‘Prior Research and
Empirical Expectations’’ section.
4. There is no definitive guidance on what number a firm should provide, so it is not certain if man-
agement is trying to provide the budgeted number, the most likely outcome, the expected value,
or some other value. We treat the reported number as a forecast and examine the properties of
the forecasts by comparing them with the realized levels. We refer to these forecasts as planned
or expected capital expenditures and store openings.
5. In our empirical analysis, we include a number of potentially important explanatory variables
but, as in similar studies, it is not possible to identify and include all possible variables.
6. This importance is reflected in research on capital budgeting (Kim, 2006), their role in valuation
(Biddle, Chen, & Zhang, 2001) and the effects of agency problems on capital expenditures
(Kang, Kumar, & Lee, 2006; Richardson, 2006). Forecasts of store openings and capital expendi-
tures are important factors in projecting future revenue growth because retail revenues basically
increase due to expanding the number of retail locations and to sales growth at existing stores.
Forecasting capital expenditures is also necessary in forecasting future free cash flows.
7. The generalizability of results for capital expenditures and store opening forecasts may be lim-
ited because management has substantial control over the realized outcomes.
8. In particular, our results complement the findings of McConnell and Muscarella (1985) and
Bryan (1997) who find stock prices respond to capital expenditure forecasts and Cole and Jones
(2004) who find that capital expenditures and store opening forecasts are associated with contem-
poraneous stock returns and future revenues and earnings.
9. See, for example, McNichols (1989), McConomy (1998), Clarkson (2000), Irani (2001), and
Choi and Ziebart (2004).
10. Ryan (1997), Lundholm (1999), Lundholm (2003), and Hirst, Jackson, and Koonce (2003) sug-
gest and provide theoretical or experimental evidence on this idea but no archival research exam-
ines how that requirement affects the accuracy of estimates. The SEC (2003) interpretative
release encourages firms to describe the past accuracy of their accounting estimates.
11. Cole (1990) and Bryan (1997) provide evidence on the frequency of some common forward-
looking disclosures. Safe harbor provisions of the Private Securities Litigation Reform Act of
1995 reduce the risk of being sued for forward-looking statements. See Cole and Jones (2005)
for additional discussion of MD&A rules.
12. Cole and Jones (2005) provide a review of research on MD&A.
13. Consistent with an interest in forward-looking disclosures, Clarkson, Kao, and Richardson (1999)
report that sell-side analysts find MD&A information useful, particularly forward-looking infor-
mation including planned capital expenditures and Epstein and Pava (1995) report that investors
they survey indicated that they would like more forward-looking information.
14. See Feldman, Govindaraj, Livnat, and Segal (2010); Davis and Tama-Sweet (2012); and Brown
and Tucker (2011).
15. Similarly analyst forecasts are value relevant but exhibit biases.
Cole and Jones 145

16. Articles that examine bias in management earnings forecasts include McNichols (1989),
McConomy (1998), Clarkson (2000), Choi and Ziebart (2004), Irani (2001), and Baik and Jiang
(2006). See Mincer and Zarnowitz (1969), Givoly (1985), and Newbold and Bos (1994) for dis-
cussion of efficiency tests. Givoly refers to this as a test of ‘‘regression’’ bias. Granger and
Newbold (1973), Diebold and Lopez (1996), Harris (1999), and Trueman, Wong, and Zhang
(2001) discuss or use tests of whether a forecast captures all available information. Other articles
refer to this property that we call sufficient-statistic efficiency as conditional efficiency (Granger
& Newbold, 1973), optimality or rationality (Diebold & Lopez, 1996), or strong efficiency
(Harris, 1999).
17. See Mincer and Zarnowitz (1969) and Newbold and Bos (1994) on the goal of maximizing
explanatory power. Maximizing the r2 is the same as minimizing the mean-squared forecast
error. Mincer and Zarnowitz (1969) discuss the idea of incremental explanatory power. They
refer to it as possessing autonomous information. Elgers and Murray (1992) test for incremental
informativeness of analyst earnings forecasts compared with statistical forecasts.
18. We discuss the other properties one at a time but combine the discussion of bias and inefficiency
because the concepts are related. In general, the factors that may reduce any of the five proper-
ties can affect other properties as well.
19. In the context of estimating the present value of future cash flows, FASB (2000) makes the same
distinction between forecasts that try to predict the expected value and forecasts that identify the
single most likely outcome.
20. Budgeted amounts are affected by incentives and constraints of the corporate budgeting process.
Lyne (1988) provides evidence for a small sample of medium-sized U.K. firms that the majority
of firms perceive a budget as a forecast of future performance, whereas a minority of firms view
budgets as a target.
21. Rogers and Stocken (2005) argue that it is easier for management to offer an intentionally biased
forecast if the outcome is more uncertain because then it is harder for users to infer management
intentionally biased the forecast on the basis of the ex post realization.
22. In our data, 75% of the capital expenditure observations and 84% of store opening observations
come from firms that either provide forecasts in all 4 years or in all years for which there is a
10-K. In contrast, management earnings forecasts are less likely to be provided annually. For
example, Rogers and Stocken (2005) report that 63% of the firms in their sample of earnings
forecasters provide a single forecast in 5 years.
23. Research has documented patterns of overconfidence in and overweighting of private information
in other forecasting contexts (Chen & Jiang, 2006).
24. Diebold and Lopez (1996) discuss all three tests of bias.
25. Efficiency and bias are related but distinct concepts. A forecast can be unbiased, with a zero
mean error, and still have coefficients that differ from 0 and 1, but biased predictions will tend
to be less efficient. In general, the set of factors that influence bias will tend to influence
efficiency.
26. Most retailers lease their stores. As a result, capital spending on new stores generally consists of
leasehold improvements and equipment purchases rather than the purchase of the stores them-
selves. Capital expenditures can also relate to remodeling or expanding existing stores, upgrading
information systems, or building a corporate office building or a new distribution facility.
27. Another reason we include these variables and most of the other historical variables is that Cole
and Jones (2004) find that they are useful in predicting future revenues and earnings changes,
which may suggest that the variables contain useful information that will also help predict future
capital expenditures and store openings. Cole and Jones do not examine the cash flow variables.
Curtis, Lundholm, and McVay (2014) find that several of the variables help predict future
revenues.
28. Fazzari, Hubbard, and Peterson (1988) find that capital expenditures are influenced by cash
flows.
146 Journal of Accounting, Auditing & Finance

29. We do not include the change in the level of store openings in our analysis because including it
leads to losing a year of observations. When we do include it, the change in store openings is
never significant and other results are unaffected.
30. Francis, Schipper, and Vincent (2003) for restaurants and Cole and Jones (2004) for retailers find
that the level and change of comparable store sales growth are value relevant.
31. We repeat our analysis including additional firms with non-retail business and results are
unchanged.
32. We examine the two forecasts separately because requiring both reduces the sample substan-
tially. Firms that offer one of the forecasts are somewhat more likely to offer the other forecast
but the final sample would have only 217 observations if we required firms to provide both
forecasts.
33. We repeat the store opening analysis including all observations with at least 20 stores (instead of
50) and the findings are similar, although explanatory power declines.
34. We repeat all of the regressions for capital expenditures and store openings after using DFFITS
to identify and remove influential observations. The findings on the five attributes we study are
unaffected.
35. Because a regression by design maximizes the explanatory power in fitting regression coeffi-
cients and the relationship between variables is unlikely to stay constant over time, it is likely
that explanatory power out of sample would be lower.
36. Variance inflation factors suggest multicollinearity is not an issue in the regressions.
37. The coefficients from Specification 2 can be used to predict store opens for firms that do not pro-
vide a store open forecast.
38. We do not examine the other properties because, consistent with Greene’s (1991) sample size
guidelines for maintaining statistical power, the tests for those properties involve estimating too
many coefficients for our sample size.
39. Ali, Klein, and Rosenfeld (1992) and Nam, Brochet, and Ronen (2012) use basically the same
approach. Because their samples are drawn from more years, they are able to use the average
regression coefficients from 5 previous years and 56 quarters, respectively, to produce their
adjusted forecasts.

References
Ali, A., Klein, A., & Rosenfeld, J. (1992). Analysts’ use of information about permanent and transi-
tory earnings components in forecasting EPS. The Accounting Review, 67, 183-198.
American Institute of Certified Public Accountants. (1994). Improving business reporting—A cus-
tomer focus: Meeting the information needs of investors and creditors. New York, NY: Author.
Baik, B., & Jiang, G. (2006). The use of management forecasts to dampen analysts’ expectations.
Journal of Accounting and Public Policy, 25, 531-553.
Bamber, L. S., & Cheon, Y. S. (1998). Discretionary management earnings forecast disclosures:
Antecedents and outcomes associated with forecast venue and forecast specificity choices. Journal
of Accounting Research, 36, 167-190.
Barron, O. E., Kile, C. O., & O’Keefe, T. B. (1999). MD&A quality as measured by the SEC and
analysts’ earnings forecasts. Contemporary Accounting Research, 16, 75-109.
Behn, B. K., Kaplan, S. E., & Krumweide, K. R. (2001). Further evidence on the auditor’s going-con-
cern report: The influence of management plans. Auditing: A Journal of Theory of Practice &
Theory, 20, 13-28.
Biddle, G. C., Chen, P., & Zhang, G. (2001). When capital follows profitability: Non-linear residual
income dynamics. Review of Accounting Studies, 6, 229-265.
Brown, S. V., & Tucker, J. W. (2011). Large-sample evidence on firms’ year-over-year MD&A modi-
fication. Journal of Accounting Research, 49, 309-346.
Bryan, S. P. (1997). Incremental information content of required disclosures contained in management
discussion and analysis. The Accounting Review, 72, 285-301.
Cole and Jones 147

Chen, Q., & Jiang, W. (2006). Analysts’ weighting of private and public information. Review of
Financial Studies, 19, 319-355.
Choi, J., & Ziebart, D. A. (2004). Management earnings forecasts and the market’s reaction to pre-
dicted bias in the forecast. Asia-Pacific Journal of Accounting & Economics, 11, 167-192.
Clarkson, P. M. (2000). Auditor quality and the accuracy of management earnings forecasts.
Contemporary Accounting Research, 17, 595-622.
Clarkson, P. M., Kao, J. L., & Richardson, G. D. (1994). The voluntary inclusion of forecasts in the
MD&A section of annual reports. Contemporary Accounting Research, 11, 423-450.
Clarkson, P. M., Kao, J. L., & Richardson, G. D. (1999). Evidence that management discussion and
analysis (MD&A) is a part of a firm’s overall disclosure package. Contemporary Accounting
Research, 16, 111-134.
Cole, C. J. (1990). MD&A trends in Standard & Poor’s top 100 companies. Journal of Corporate
Accounting & Finance, 2, 127-136.
Cole, C. J., & Jones, C. L. (2004). The usefulness of MD&A Disclosures in the retail industry.
Journal of Accounting, Auditing & Finance, 19, 361-388.
Cole, C. J., & Jones, C. L. (2005). Management discussion and analysis: A review and implications
for future research. Journal of Accounting Literature, 24, 135-174.
Curtis, A., Lundholm, R. J., & McVay, S. E. (2014). Forecasting sales: A model and some evidence
from the retail industry. Contemporary Accounting Research, 31, 581-608.
Davis, A. K., & Tama-Sweet, I. (2012). Managers’ use of language across alternative disclosure out-
lets: Earnings press releases versus MD&A. Contemporary Accounting Research, 29, 804-837.
Diebold, F. X., & Lopez, J. A. (1996). Forecast evaluation and combination. In G. S. Maddala & C.
R. Rao (Eds.), Handbook of statistics (Vol. 14, pp. 241-268). Amsterdam, The Netherlands:
Elsevier.
Elgers, P., & Murray, D. (1992). The relative and complementary performance of analyst and secu-
rity-price-based measures of expected earnings. Journal of Accounting & Economics, 15, 303-316.
Epstein, M. J., & Pava, M. L. (1995). Shareholders’ perceptions on the usefulness of MD&As.
Managerial Finance, 21, 68-83.
Fazzari, S. R., Hubbard, R. G., & Peterson, B. C. (1988). Financing constraints and corporate invest-
ment. Brookings Papers on Economic Activity, 1, 141-206.
Feldman, R., Govindaraj, S., Livnat, J., & Segal, B. (2010). Management’s tone change, post earnings
announcement drift and accruals. Review of Accounting Studies, 15, 915-953.
Financial Accounting Standards Board. (2000). Statement of financial accounting concepts No. 7:
Using cash flow information and present value in accounting measurements. Norwalk, CT:
Author.
Financial Accounting Standards Board. (2001). Improving business reporting: Insights into enhancing
voluntary disclosures. Norwalk, CT: Author.
Francis, J., Schipper, K., & Vincent, L. (2003). The relative and incremental explanatory power of
earnings and alternative (to earnings) performance measures for returns. Contemporary
Accounting Research, 20, 121-164.
Fried, D., & Givoly, D. (1982). Financial analysts’ forecasts of earnings: A better surrogate for
market expectations. Journal of Accounting & Economics, 4, 85-107.
Givoly, D. (1985). The formation of earnings expectations. The Accounting Review, 60, 372-386.
Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate finan-
cial reporting. Journal of Accounting & Economics, 40, 3-73.
Granger, C. W. J., & Newbold, P. (1973). Some comments on the evaluation of economic forecasts.
Applied Economics, 5, 35-47.
Greene, W. H. (1991). Econometric analysis. Upper Saddle River, NJ: Prentice Hall.
Harris, R. D. F. (1999). The accuracy, bias and efficiency of analysts’ long run earnings growth fore-
casts. Journal of Business, Finance & Accounting, 26, 725-755.
Hirst, D. E., Jackson, K. E., & Koonce, L. (2003). Improving financial reporting by revealing the
accuracy of prior estimates. Contemporary Accounting Research, 20, 165-193.
148 Journal of Accounting, Auditing & Finance

Hutton, A. P., & Stocken, P. C. (2009, June 8). Prior forecasting accuracy and investor reaction to
management earnings forecasts (Working paper). Chestnut Hill, MA: Boston College. Retrieved
from http://ssrn.com/abstract=817108
International Accounting Standards Board. (2010). IFRS practice statement: Management commen-
tary: A framework for presentation. London, England: Author.
Irani, A. J. (2001). Determinants of bias in management earnings forecasts. Accounting Enquiries, 10,
33-86.
Kang, S., Kumar, P., & Lee, H. (2006). Agency and corporate investment: The role of executive com-
pensation and corporate governance. Journal of Business, 79, 1127-1147.
Kim, D. (2006). Capital budgeting for new projects: On the role of auditing in information acquisi-
tion. Journal of Accounting & Economics, 41, 257-270.
Li, F. (2010). The determinants and information content of the forward-looking statements in corpo-
rate filings—A naı̈ve Bayesian machine learning approach. Journal of Accounting Research, 48,
1049-1102.
Lundholm, R. J. (1999). Reporting on the past: A new approach to improving accounting today.
Accounting Horizons, 13, 315-322.
Lundholm, R. J. (2003). Historical accounting and the endogenous credibility of current disclosures.
Journal of Accounting, Auditing & Finance, 18, 207-229.
Lyne, S. R. (1988). The role of the budget in medium and large UK companies. Accounting and
Business Research, 18, 195-208.
McConnell, J. J., & Muscarella, C. J. (1985). Corporate capital expenditure decisions and the market
value of the firm. Journal of Financial Economics, 14, 399-422.
McConomy, B. J. (1998). Bias and accuracy of management earnings forecasts: An evaluation of the
impact of auditing. Contemporary Accounting Research, 15, 167-195.
McNichols, M. (1989). Evidence of informational asymmetries from management earnings forecasts
and stock returns. The Accounting Review, 64, 1-27.
Mincer, J., & Zarnowitz, V. (1969). The evaluation of economic forecasts. In J. Mincer (Ed.), Economic
forecasts and expectations (pp. 3-46). New York, NY: National Bureau of Economic Research.
Muslu, V., Radhakrishnan, S., Subramanyam, K. R., & Lim, D. (in press). Forward-looking MD&A
disclosures and the information environment. Management Science.
Nam, S., Brochet, F., & Ronen, J. (2012). The predictive value of accruals and consequences for
market anomalies. Journal of Accounting, Auditing & Finance, 27, 151-176.
Newbold, P., & Bos, T. (1994). Introductory business and economic forecasting. Cincinnati, OH:
South-Western Publishing.
Patell, J. M. (1976). Corporate forecasts of earnings per share and stock price behavior: Empirical
tests. Journal of Accounting Research, 14, 246-276.
Pava, M. L., & Epstein, M. J. (1993). How good is MD&A as an investment tool? Journal of
Accountancy, 175, 51-53.
Penman, S. H. (1980). An empirical investigation of the voluntary disclosure of corporate earnings
forecasts. Journal of Accounting Research, 18, 132-160.
Richardson, S. (2006). Overinvestment of free cash flow. Review of Accounting Studies, 11, 159-189.
Rogers, J. L., & Stocken, P. C. (2005). Credibility of management forecasts. The Accounting Review,
80, 1233-1260.
Ryan, S. G. (1997). A survey of research relating accounting numbers to systematic equity risk with
implications for risk disclosure policy and future research. Accounting Horizons, 11, 82-95.
Sun, Y. (2010). Do MD&A disclosures help users interpret disproportionate inventory increases? The
Accounting Review, 85, 1411-1440.
Trueman, B. (1986). Why do managers voluntarily release earnings forecasts? Journal of Accounting
& Economics, 8, 53-71.
Trueman, B., Wong, M. H. F., & Zhang, X. (2001). Back to basics: Forecasting the revenues of inter-
net firms. Review of Accounting Studies, 6, 305-329.
U.S. Securities and Exchange Commission. (n.d.). Regulation S-K. Washington, DC: Author.
Cole and Jones 149

U.S. Securities and Exchange Commission. (1989). Management’s discussion and analysis of finan-
cial condition and results of operations; Certain investment company disclosures (Securities Act
Release No. 6835). Washington, DC: Author.
U.S. Securities and Exchange Commission. (2003). Financial reporting release No 72, commission
guidance regarding management’s discussion and analysis of financial conditions and results for
operations (Securities Act Release No 33-8350). Washington, DC: Author.
U.S. Securities and Exchange Commission. (2010). Interpretation: Commission guidance on presenta-
tion of liquidity and capital resources disclosures in management’s discussion and analysis.
(Securities Act release Nos. 33-9144). Washington, DC: Author.